Volcker Rule reins in banks' riskiest trading

Dec. 10, 2013
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Big banks such as JPMorgan Chase face restriction on trading activities for their own accounts under the Volcker Rule that federal regulatory agencies are set to vote on Dec. 10. / JUSTIN LANE, European Pressphoto Agency

by Tim Mullaney, USA TODAY

by Tim Mullaney, USA TODAY

Five federal regulators moved Tuesday to approve a key component of the sweeping financial reform law aimed at preventing another financial crisis and reining in banks' riskiest trading practices.

The Federal Deposit Insurance Corp., the Federal Reserve and the Securities and Exchange Commission approved the final version of the Volcker Rule on Tuesday morning. The Commodity Futures Trading Commission and the Comptroller of the Currency approved the rule without a public meeting.

The rule would prohibit banks from buying and selling most investments for their own accounts. But there are broad exemptions: Banks can own securities when it's necessary to serve trading and investment banking clients; they can own U.S. government debt; and they can own securities that hedge other positions the banks legally own.

"It's a very serious blow to the gambling culture of Wall Street,'' said Dennis Kelleher, CEO of Better Markets, a non-profit investor-advocacy group. "It's much better than many people expected.''

The largest banks would be required to comply with the rule by July 2015. Other banks would have until 2016.

The measure, named for Paul Volcker, the former Federal Reserve chairman who conceived it, forces banks to prove that their trading is reasonably related to client needs, and that any hedging strategies are directly related to offsetting a specific, identifiable risk. That represents a compromise between banks that wanted more leeway to hedge, and regulators who thought a broader loophole would let banks flout the rule by trading routinely and making up a hedging rationale only if they were caught.

What regulators wanted to prohibit was banks trying to make short-term trades with depositors' money, even indirectly, or using it to invest in private-equity deals, said Los Angeles banking attorney Patricia Trendacosta, who has represented banks including Citigroup and Bank of America. The restrictions are similar to those imposed after the 1929 crash that led to the Great Depression, she said.

The goal was also to protect the federal deposit insurance fund by forcing banks to spin off trading operations, said FDIC Vice Chairman Thomas Hoenig.

Proprietary trading "should be conducted away from the safety net in firms that do not engage in commercial banking,'' he said. "These firms would be allowed to succeed or fail in an open market and not have the advantages of the safety net and its subsidy for speculative trading.''

How much the law changes Wall Street depends partly on how it's applied, regulators said.

"A specific trade may be either permissible or impermissible, depending on the context and circumstances within which that trade is made,'' Federal Reserve Gov. Daniel Tarullo said. "While the proposal before us articulates standards for making those distinctions, those standards will necessarily be developed further as they are applied.''

The Volcker Rule also must be approved by the Commodity Futures Trading Commission and the Office of the Comptroller of the Currency. All the agencies are set to act, despite a Washington snowstorm that shut most local government operations for the day. CFTC spokesman Steven Adamske said his agency will not hold a public meeting, but commissioners will approve the rules in writing.

Regulators hope the rules mean banks take less risk, operate with less leverage and have more consistent financial results in the future, CLSA banking analyst Mike Mayo said.

Because banks have already shed most of their proprietary trading businesses in anticipation of the rule, the final version should have little new effect on bank profits, said Raymond James analyst Anthony Polini. The rule bars U.S. banks from some investments that foreign banks can make outside the U.S., but those are too small a part of the business at banks such as Citi and Bank of America to be material, he added.

The agencies devoted nearly two years to studying 18,000 public comments, agency officials said. The 70-page rule itself is accompanied by an 850-page preamble that addresses the comments and lays out the rationale for the rules.

In the final days before approval, the most contentious issues concerned how banks could buy and sell securities to hedge broad, macroeconomic risk. The final rule cuts off that strategy for the most part, requiring that banks document the specific risks they're trying to offset. Officials said this was a specific reaction to JPMorgan Chase's $6 billion loss on the "London Whale'' trade, which involved trading derivatives in a botched attempt to hedge interest rate risk.

JPMorgan CEO Jamie Dimon said in 2012 that the trades would have been legal under a draft of the Volcker Rule released in 2011.

The new rules require CEOs of large banks to attest that their institutions have risk controls in place to enforce compliance with the new standards, but do not force them to swear that the banks do not own any prohibited investments, officials said.

"You put it in the CEO's lap if something goes wrong, which is where it was already,'' Polini said.